Strategic implications of the surprising fall in UK online grocery shoppers

According to a recent report from Mintel ( the proportion of people buying groceries online in the UK fell from 49% in 2016 to 45% in 2018. While online remains one of the fastest growing channels in value terms, driven by existing customers spending more, growth has slowed significantly as supermarkets struggle to attract new customers.

This may help explain the decision by Tesco, still by far the UK’s largest online grocer, to de-emphasise its online business, in order to reduce the negative margin impact. Tesco’s online grocery sales rose by just 2.8% in the last quarter, compared to continued double-digit retail sales growth at online specialist Ocado. Tesco may feel that the potential market share losses may not be that significant if the online grocery market as a whole is already approaching saturation.

Not surprisingly, a preference for choosing fresh products in person was by far the most commonly cited reason (73%) preventing people from buying groceries online, with excessive delivery charges (24%) a distant second. Despite the fact that most people once they’ve started ordering their groceries online quickly get over their previous preference for buying fresh food in person (Ocado’s fresh food penetration is nearly 50% - higher than many of its store-based competitors), getting people to give it a try is becoming increasingly difficult in the UK.

Such signs that growth may be stalling in a market where online’s share is high relative to the rest of Europe and the US but still accounts for just 7% of the total grocery market, has significant strategic implications for those playing catch-up. This includes the likes of Amazon, Walmart, and Kroger, which are already engaged in an online space race, as well as all those considering how best to deal with the crossfire. It also supports the accelerated development of hybrid store concepts such as Alibaba’s Hema and Alert Innovation’s Novastore (, which uses robots to pick packaged goods, leaving customers to choose their own fresh food.

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Why the world's largest online grocer has gone into hiding

With annual online grocery sales of around £3.5bn in the UK alone, Tesco Plc remains the world’s biggest online grocer, ahead of Amazon and Walmart. However, at Tesco’s latest interim results presentation last week, for the first time in over a decade there was not a single mention or question regarding this part of its business, aside from the fact that it grew by 3.5% - which is broadly inline with Tesco’s offline grocery sales.

The obvious reason for this silence, which contrasts sharply with all the noise US grocers are making about their burgeoning e-commerce growth, is that market leader Tesco finds itself stuck firmly between the rock of negative profit impact and the hard place of losing market share to pure online grocers.

Three years ago Tesco’s online grocery sales were still rising by nearly 15% and its share of the online market was around 38% (vs 28% offline). The slowdown is the result of a conscious decision Tesco has taken to try to improve the profitability - or more precisely, to reduce the burden of maintaining - its online grocery business over the last couple of years by raising minimum order values and service fees. Its two largest competitors, Sainsbury and Asda, have followed Tesco’s lead.

At the same time however, pure online grocer Ocado has opened two new fulfillment centres and maintained an aggressive marketing campaign to lure new shoppers with discounts and free delivery, resulting in continued double-digit retail sales growth. Amazon has also been rolling out its Fresh and Prime Now free same day grocery delivery service in major UK cities, aided by a wholesale agreement with Morrisons, the UK’s fourth largest (and most vertically integrated) food retailer.

Tesco’s decision to prioritize profits over online market share (its loss-making Tesco Direct online general merchandise business was shut down in July this year) is effectively a bet that the pure online grocers’ growth will hit a natural saturation barrier sooner rather than later - i.e., before it starts seriously affecting in-store sales.

As the online grocery space race gathers pace in the US, it’s worth reflecting on the fact that the largest online grocer in the UK, where penetration is still approximately double that in the US, has chosen to de-emphasise this part of its business by adopting such a potentially risky wait-and-see attitude.

A sign perhaps that some of the energy currently being expended on gaining first-mover “advantage” by copying existing fulfillment strategies should be diverted to testing truly novel ways to integrate offline and online more effectively and profitably.

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Why Kroger's deal with Ocado is a strategic mistake

The most remarkable thing about Kroger's deal with the UK's Ocado to build up to 20 large Customer Fulfilment Centers (CFCs) across the US is not how many £billions have been suddenly added to Ocado’s market value, nor the cutting-edge nature of the technology that will now be at Kroger's disposal. It is that virtually no-one appears to realize the negative aspects of this move for Kroger, and the US supermarket sector in general. Indeed, far from being a coup, it is a strategic mistake. One could even go so far as to say Kroger has bought an expensive shovel to dig its own grave deeper. There are three reasons for this:

1. Dedicated order fulfilment centres directly undermine store sales and profits

Picking from stores may not be the most efficient way to fulfil on line orders in terms of speed and accuracy, but it remains the most cost-effective method for brick and mortar operators as it leverages their existing fixed costs and minimises delivery distances. The efficiencies from large centralised automated facilities in terms of faster picking and lower wastage are far outweighed by the fact that the cost of building and operating them is largely incremental to that of the existing store business. Delivery is also more expensive and less timely.

The main arguments for centralised picking facilities (or “Customer Fulfilment Centres” as Ocado calls them) are scalability and superior service levels. However, even in the UK, where stores are much smaller and sales densities much higher than in the US, in-store picking remains the norm. This then leaves the question of whether the superior service metrics that automated picking facilities deliver compared to in-store picking, in terms of availability, picking accuracy, freshness and range, can generate sufficient market share gains to offset the extra capital and operating costs.

In markets where Kroger already has a significant presence, the answer is almost certainly no, due to cannibalisation of sales and profits at their existing stores, whose costs are mostly fixed.

It might be possible in markets where Kroger has minimal presence (such in the Northeast) and hence can go after largely new custom. However, the profitability of pure online grocers outside of very dense urban zones appears marginal, based on data from both Peapod in the US and Ocado in the UK. Furthermore, the competitive impact of Amazon’s ambitions in grocery following its purchase of Whole Foods has yet to be felt.

2. Online grocery inevitably adds more cost and complexity than sales.

This applies even for first-movers, whose advantage is quickly eroded as competitors react to keep their higher-spending (i.e., loyal) customers. Kroger’s deal with Ocado is set to accelerate the online space race in the US, which can only intensify margin pressure for all supermarket operators.

This has been demonstrated very clearly in the UK, where the online shift is relatively advanced - partly due to the very aggressive initial growth strategy pursued by market leader Tesco. However, the cost of subsidizing home delivery helped undermine Tesco's ability to invest pro-actively to stem the growth of German limited assortment discounters Aldi and Lidl in the wake of the 2008 financial crisis. The result has been a 60% fall in Tesco’s profits over the last six years. The negative impact of e-commerce growth on profits also explains why the UK’s major brick and mortar supermarket chains have recently decided to raise fees and minimum order thresholds in order to slow their online growth, even if it means losing market share to Ocado and Amazon.

Kroger is already starting to feel the pain, warning last year that the expansion of Clicklist is a drain on store profitability that will likely worsen as the program gathers pace. That’s despite charging $4.95 for a service which is free at Walmart, and before the acceleration of home delivery, which is even more negative for margins and is now free for Amazon Prime members.

As supply ramps up, competition will drive fees down - as happened in the UK’s initial growth phase. Up to now, US grocers have been fortunate (smart?) enough to be able to share the financial burden of subsidising home delivery with the shareholders of the likes of Instacart and Shipt. The presence of these third parties has also helped maintain price discipline. Kroger’s deal with Ocado now threatens to disrupt this as a result of the stimulus it gives to competitors as well as its own incentive to minimise start-up losses by ramping up capacity utilisation at these expensive warehouses as quickly as possible.

Kroger's most recent positive quarterly result should therefore be seen as the calm before the online storm hits. 

3. Automation set to move to the store level

Of course, it could be argued that whatever the negative impact on near or medium-term profits, it is better to take the fight to Amazon pro-actively, instead of waiting for the e-commerce giant to unleash its full potential in grocery.

Leaving aside the danger of helping the genie out of the bottle before its true nature is known and potential impact can be contained, this brings us to the third and possibly most important reason why this deal is a bad move for Kroger. By the time its Ocado CFCs are up and running – i.e., in around three years’ time – the picking technology is likely to be out-dated and even potentially obsolete.

This is because of a move towards automation at the store level, which an increasing number of major grocers in the US and Europe realise is the best way to a) leverage existing fixed assets; b) minimise last-mile costs; c) match capacity growth with demand more progressively; and d) create an integrated supply chain serving both stores and online. There are at least three start-ups and one existing provider of picking automation that are working on systems that are specifically designed to be used as micro-fulfilment centres either next to or inside grocery stores.

Furthermore it can be safely assumed that Amazon, with all the resources at its disposal and a superior innovation culture, is also working to develop a picking automation system that is better suited to grocery than Kiva (which was developed for general merchandise) and could be used to support Whole Foods. Indeed, an article in the New York Post published in February 2017 described how Amazon is looking to use robots inside the store to develop a hybrid cashier-less store whereby packaged goods are bought online and picked automatically in a micro-fulfillment centre located within the store, leaving customers the pleasure of choosing their own fresh food. Such a store concept would be far larger and more scalable than Amazon Go. In fact, by combining a superior customer experience with much lower operating (notably labour) costs and hence prices, it could go a long way towards displacing traditional supermarkets.

The future of automated grocery fulfilment is with stores, not huge centralised facilities - aka double-running cost centres. 

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Counting the cost of staying in the omni-channel game

On Monday Carrefour's new CEO Alexandre Bompard presented his five year plan for Europe's largest food retailer, the highlights of which were €2bn in cost savings, a focus on quality food sourcing and traceability, a tie-up with Tencent and Yonghui in China, and €2.8bn investment to accelerate ecommerce with the aim of achieving the same share of the French grocery market online as it currently has offline (20%). The plan was well received by shareholders, sending the share price up 6%.

While the ambition and broad outline of Bompard's plan appears admirable, commentators and investors seem to have missed a rather important, not so positive point. What Carrefour has just done is to quantify how much the growth of ecommerce is adding to the cost of staying in the game (i.e., maintaining market share). For investors, that means €2.8bn of incremental opex and capex (the mix is as yet unclear) to be deducted and added respectively to the top and bottom parts of the ROI calculation. While overall annual capex is being cut by 10% to €2bn, this is at the expense of organic growth from new stores and remodelings. 

We’ve already seen the impact of this increased "pay-to-play" rate in the UK grocery market, where margin pressure arising from the online race space that kicked off over a decade ago was one of the factors that made market "leaders" Tesco and Asda reluctant to take pre-emptive price-cutting action to stem the growth of Aldi and Lidl in the wake of the 2008 financial crisis and recession. 

A similar space race is now about to occur in France, driven by Carrefour trying to play catch up with Leclerc and the fear of Amazon ramping up its grocery presence. Ditto the US, where Kroger’s CFO already warned at quarterly results last September that the expansion of Clicklist is a drain on store profitability.

There's no doubt that ClickList is a headwind on earnings currently and we've even continued to accelerate the speed in which we put ClickList in, so it's an incremental headwind,” Kroger said. And that’s despite them charging $4.95 for the service, which is free at Wal-Mart, and before i) the acceleration of home delivery, which surveys show is preferred to click and collect by three-quarters of US consumers in markets where they have the choice; and ii) Amazon integrating Whole Foods properly.

In my view the increasing cost of staying in the omni-channel grocery game is going to be a bigger issue than the growth of Aldi and Lidl in the medium-term. The only way out is to automate online order fulfillment down to the store level, so you are leveraging instead of deleveraging existing fixed assets, and to shift the corporate mindset from optimisation of the existing business model to fundamental transformation.

Such reinvention by incumbents from within is of course notoriously hard to contemplate, let alone execute.  Currently it is the former "pure online" players such as Amazon and Alibaba that are leading the transformation of grocery retail. This may help explain why the world's biggest brick and mortar players are suddenly rushing to form partnerships with their online counterparts, i.e.: Carrefour - Tencent, Walmart - Rakuten &, Kroger - Alibaba. These look like smart strategic moves and on paper such combinations have many attractions, if the cultural and organisational challenges can be overcome - the $trillion question. 

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Amazon's acquisition of Whole Foods taking us back to the future of food retail?

Most commentators see Amazon's bid to acquire Whole Foods as a game-changing if opportunistic move, with a minority in useful disagreement. The consensus is that Amazon probably does not yet know exactly what it wants to do with Whole Foods, but will experiment until it finds the best way to fulfill its prime aim of satisfying customers. However, to my knowledge no-one has attempted to describe in any detail how Amazon could leverage the stores as delivery hubs more effectively than brick and mortar operators, or question the extent to which the technology being used at its "Go" trial stores could be scaled up to accommodate a much larger range of products, including loose produce and items from service counters, that are a fundamental part of Whole Foods' stores and brand equity.

The first issue depends at least partly on how efficient Amazon's Kiva robotic picking system is compared to others that are aimed specifically at the grocery market. Any advantage Amazon may have today could be negated by next generation systems currently in development, especially if they allow cost-efficient automation at store level.

The second question regarding the scalability of "Go" technology is more difficult to answer, especially as it has yet to be proven effective at the trial stage in very small stores. My belief is that the current configuration of sensors and cameras etc will only work for a limited range of packaged goods - i.e., a convenience store format. However, that does not mean that Amazon will not find other ways of automating the tedious parts of the grocery store experience, notably the selection of center store products, and checkout. 

This leads to the question of whether Amazon will reinvest cost savings from automation to retain or even augment the high touch, human element that differentiates good stores in general, and Whole Foods in particular, from online and offline competitors. CEO Jeff Bezos's oft-quoted (by me at least) view of staff as "annoyingly variable" would suggest not. On the other hand, if he wants to deliver on his prime purpose of customer satisfaction, cutting out the human aspect of personalised service is probably not a good idea. 

Traditional food retailers looking for the usual easy ways to cut costs may want to reflect on this as they wait to see how the Bezos-Mackey marriage works out. 



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Time to react to the elephant in the online grocery room

A recent report from Nielsen & FMI projects that 20% of grocery sales in the US will be made online by 2025. What I find amazing about this prediction is not the figure itself - which is really anyone's guess - but that no-one has commented on the impact this would have on sector profitability. The unfortunate fact is that unless there is a significant reduction in physical floor space and/or major change in order fulfillment methods, and assuming home delivery becomes the dominant model as it has in the UK, a 20% online shift would result in supermarket industry profits falling by up to 50% due to i) the incremental costs of running dedicated picking centres and ii) deleverage of store fixed assets and costs. (Note the detailed modelling behind this estimate was one of the last pieces of work I carried out as a financial analyst and was one of the reasons I changed career to try to bring some solutions to what I call the "online cannibalisation conundrum".)

That such a future is just too bleak or remote for industry executives to admit publicly or even contemplate privately is understandable. However, one would think that external industry consultants and commentators could apply their critical facilities to alert others to the glaring elephant in the grocery room - i.e., the fact that for the grocery market as a whole online adds cost and complexity but not sales and hence will inevitably dilute margins. (This applies even to first-movers, whose advantage tends not to last very long as competitors react aggressively to prevent their high spending online customers from defecting.) Their collective failure to do so reflects either a lack of understanding of the economics of multi-channel grocery, or a fear of offending current or potential consulting clients by being the first to bear such bad news without being in a position to provide a solution. Either way, the silence is unhelpful for the industry and needs to be broken. 

These days most of the commentary regarding threats to traditional grocers relates to the expansion of limited assortment discounters Aldi and Lidl (the LADs). There is indeed a link between the growth of the LADs and online. One of the reasons the big Four UK supermarket groups failed to cut prices quickly enough to stem the LADs' growth during the post 2008 recession was the increasing extent to which they were having to subsidise the fulfilment of online orders. In the battle to attract/retain high spending online customers, the average fee for home delivery fell from £6 in 2008 to just £2 by 2013. Meanwhile, market leader Tesco was busy building large dedicated order fulfilment centres in order to ease the pressure on in-store picking (which Tesco found starts to impact the store experience for regular customers when online sales penetration reaches around 8-10%). Whatever gains were made in picking productivity were far outweighed by the additional costs of running these new facilities, and longer, more expensive delivery routes. Furthermore, this increasing investment in making it easier and cheaper for customers not to come into their stores was being partly funded by cuts to staff and hence service in stores, thus narrowing one of the mainstream supermarkets' main points of difference against the LADs.  

With Amazon now accelerating its move into grocery with not just Fresh but also Prime Now, Pantry, Dash, and plans for various types of physical locations, it is high time for food retailers' online strategy to include more than just connecting with customers digitally and allowing them to order online for pickup at store or home delivery. They need to start thinking about the longer term financial implications and looking for solutions for a problem that has already decimated the profitability of UK supermarkets and still has a lot further to go: the simultaneous growth of LADs and online.

Is anyone listening I wonder...  

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Amazon's stepped-up grocery drive to accelerate online space race

According to an article published a few days ago in the WSJ that has attracted a lot of attention, Amazon is planning to open convenience stores selling perishable items such as milk, meat, fruit and vegetables. Customers will also be able to order packaged goods with longer shelf lives for same day delivery, using their mobile phones or possibly in-store touch screens. The report, whose main source is "people familiar with the matter", notes that these stores may take a year or more to open while the company scouts locations and the plan (known internally as "Project Como") could be shelved because of financial or operational concerns. 

That Amazon wants to test brick and mortar locations to help expand its Fresh business should not come as such a surprise. Previous reports earlier this year already identified two locations in California (Sunnyvale and the Bay area) where Amazon appears to be developing drive-up grocery pickup locations, and according to the WSJ article one such site is due to open in Seattle (where Amazon Fresh was first launched) in just a few weeks time. Enabling pick up at or delivery from physical sites near customers' homes is the best way for Amazon to lower last mile fulfilment costs and to try to eliminate one of traditional supermarkets' main advantages over pure online.

The very limited rollout of Amazon's lockers in 7/11 stores in the US suggests this model is not working particularly well, for non-perishables at least. Nor is it very scalable, given the stores' tiny size. However, combining online orders with walk-in sales from custom-built stores is already a profitable model for California-based hybrid supermarket chain There could be significant potential advantages from configuring sites and managing inventory in a way that leverages Amazon's particular logistical capabilities and customer insights. What is not yet clear is the part that Kiva, the robotic picking company Amazon bought four years ago, will play in assembling online grocery orders more efficiently and the extent to which this activity may be automated at the store level. 

What is clear is that this latest news, coming on the heels of a shift in Amazon Fresh's pricing model for home delivery from a yearly subscription of $299 (including Prime) to a monthly fee of $14.99 (on top of $99 a year for Amazon Prime) and the recent integration of Amazon Fresh into's main website, signals an acceleration in the online grocery space race in the US. The online giant's moves coincide with Walmart's aggressive rollout of free curbside pickup and last week's statement by its new head of e-commerce Marc Lore: "We're going to be really focused on winning in fresh and consumables over the next couple of years."

The US market is entering the phase where downward pressure on service fees and much greater availability and quality of online fulfilment options combine to drive greater customer take-up for online grocery. While this is good news for time-pressed grocery customers, it presents a major challenge to grocers' profitability, as the subsidy they will have to pay just to keep their valuable multi-channel shoppers rises.

The desire to maintain profitability in the face of rising e-commerce costs is one of the reasons the UK's major grocers (including Asda, a Walmart subsidiary) failed to cut prices in time to slow the growth of hard discounters Aldi and Lidl. It will be interesting to see how US grocers deal with the twin threat that is now headed their way. 

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More twists in the tale at my local Waitrose

In a previous blog ("A new meaning for customer service") I described how during a visit to the fish counter at my local newly renovated Waitrose I ended up advising the nice young lad working there (I'll call him Bob for now) about the benefits of Cornish sardines (they are brilliantly cheap, sustainable, local, healthy, tasty and easy to cook), and how I'd had to leave a queue of customers that started forming who were eager to share in this information. 

What happened on my next encounter with Bob the apprentice fishmonger was even more enlightening. As soon as he saw me approach the counter, his face lit up and he greeted me with "Hello, you're the sustainable fish guy!" He then said that what I had told him last time had led him to do some research on his own to support what he had heard from me. I told him well done and that I was happy I had piqued his interest to such an extent. So far, so uplifting. 

On the following occasion that I visited the fish counter, it was manned by one of his young colleagues, while our friend Bob was further down serving customers on the deli counter. So I asked the new guy if he could tell me which fish were the most sustainable. As he drew a blank, I called across to Bob to ask if he could help enlighten his colleague. Looking quite chuffed Bob replied "The sardines or mackerel". However, when I asked why they were so cheap and sustainable, he looked less happy, muttering that he had forgotten exactly why. Ditto when I followed up with a question about the health benefits of these oily fish (Omega 3 good for the heart and brain).

On the one hand, this experience shows how a little knowledge can be enough to stimulate someone's natural curiosity, especially when it makes their job more interesting and rewarding. On the other, it highlights the importance of on-going training. Unless people are actively encouraged to learn more and put their new knowledge into practice, both the curiosity and knowledge can wither away.

In the context of supermarkets, which employ more people than any other private sector doing (let's be honest) mostly tedious tasks, the fact that those on the frontline (i.e., cashiers and shelf restockers, not just those working on service counters) often know less about what they are selling than their customers surely represents a huge waste of pent-up curiosity and energy. Or viewed more positively, a tremendous opportunity - especially given the introduction of the Living Wage and apprenticeship levy. In the meantime, I look forward to chatting to Bob and his colleagues more often. 


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